Friday, 19 April 2013

Credit Theory of Money

Single and split tally sticks in the Swiss Alpine Museum - similar items may have been used in debt based economic systems thought to pre-date the use of coinage.

Credit theories of money, also called debt theories of money are concerned with the relationship between credit and money. Proponents of these theories, such as Alfred Mitchell-Innes, will sometimes emphasize that credit and debt are the same thing, seen from different points of view.[1]
Proponents assert that the essential nature of money is credit (debt),
at least in eras where money is not backed by a commodity such as gold.
Two common strands of thought within these theories are the idea that
money originated as a unit of account for debt, and the position that money creation
involves the simultaneous creation of money and debt. Some proponents
of credit theories of money argue that money is best understood as debt
even in systems often understood as using commodity money. Others hold that money equates to credit only in a system based on fiat money, where they argue that all forms of money including cash can be considered as forms of credit money.
The first formal Credit theory of money arose in the 19th century. Anthropologist David Graeber
has argued that for most of human history, money has been widely
understood to represent debt, though he concedes that even prior to the modern era, there have been several periods where rival theories like Metallism have held sway.

Scholarship

The earliest modern thinker to formulate a credit theory of money was Henry Dunning Macleod, with his work in the 19th century, most especially with his The Theory of Credit (1889). Macleod's work was expanded on by Alfred Mitchell-Innes in his papers What is Money? (1913) and The Credit Theory of Money (1914),[2]
where he argued against the then conventional view of money arising as a
means to improve the practice of barter. In this alternative view, commerce and taxation created obligations between parties which were forms of credit and debt. Devices such as tally sticks were used to record these obligations and these then became negotiable instruments which could function as money. As Innes puts it in his 1914 article :

The Credit Theory is this: that a sale and purchase
is the exchange of a commodity for credit. From this main theory
springs the sub-theory that the value of credit or money does not depend
on the value of any metal or metals, but on the right which the
creditor acquires to "payment," that is to say, to satisfaction for the
credit, and on the obligation of the debtor to "pay" his debt and
conversely on the right of the debtor to release himself from his debt
by the tender of an equivalent debt owed by the creditor, and the
obligation of the creditor to accept this tender in satisfaction of his
credit.

Innes goes on to note that a major problem in getting the public to
understand the extent to which monetary systems are debt based is the
challenge in persuading them that "things are not the way they seem" [3]
In his 2011 book Debt: The First 5000 Years, the anthropologist David Graeber
asserted that the best available evidence suggests the original
monetary systems were debt based, and that most subsequent systems have
been too. Exceptions where the relationship between money and debt was
less clear occurred during periods where money has been backed by bullion, as happens with a gold standard.
Graeber echoes earlier theorists such as Innes by saying that during
these eras population perception was that money derived its value from
the precious metals of which the coins were made,[4]
but that even in these periods money is more accurately understood as
debt. Graeber states that the three main functions of money are to act
as: a medium of exchange; a unit of account; and a store of value. Graeber writes that since Adam Smith's time, economists have tended to emphasise money as a medium of exchange.[5] For Graeber, when money first appeared its primary purpose was to act as a unit of account, to denominate debt. He writes that coins were originally created as tokens which represented a unit of account rather than being an amount of precious metal which could be bartered.[6]
Economics commentator Philip Coggan holds that the world's current monetary system became debt based after President Nixon suspended the link between money and gold in 1971. He writes that "Modern money is debt and debt is money". Since the 1971 Nixon Shock, debt creation and the creation of money increasingly took place at once. This simultaneous creation of money and debt occurs as a feature of Fractional reserve banking.
After a commercial bank approves a loan, it is able to create the
corresponding amount of money, which is then acquired by the borrower
along with a similar amount of debt.[7] Coggan goes on to say that debtors often prefer debt based monetary systems such as Fiat money over commodity based systems like the gold standard,
because the former tend to allow much higher volumes of money to
circulate in the economy, and tend to be more expansive. This makes
their debts easier to repay. Coggan refers to Bryan's 19th century Cross of Gold speech
as one of the first great attempts to weaken the link between gold and
money; he says the former US presidential candidate was trying to expand
the monetary base
in the interests of indebted farmers, who at the time were often being
forced into bankruptcy. However Coggan also says that the excessive debt
which can be built up under a debt based monetary system can end up
hurting all sections of society, including debtors.[8]
In a 2012 paper, economic theorist Perry Mehrling notes that what is commonly regarded as money can often be viewed as debt. He posits a hierarchy of assets with gold[9] at the top, then currency, then deposits and then securities. The lower down the hierarchy, the easier it is to view the asset as reflecting someone else's debt.[10] A later 2012 paper from Claudio Borio of the BIS made the counter-intuitive case that it's loans that give rise to deposits, rather than the other way round.[11]

Advocacy

The conception that money is essentially equivalent to credit or debt
has long been used by those advocating particular reforms of the
monetary system, and by commentators calling for various monetary policy responses to events such as the Financial crisis
which began in 2008. A view held in common by most recent advocates,
from all shades of political opinion, is that money can be equated with
debt in the context of the contemporary monetary system. The view that
money is equivalent to debt even in systems based on commodity money tends to be held only by those to the left of the political spectrum. Regardless of any commonality in their understanding of credit theories of money, the actual reforms proposed by advocates of different political orientations are sometimes diametrically opposed.[8]

Advocacy for a return to a gold standard or similar commodity based system.

Former US presidential candidate Ron Paul has spoke out against Fiat money, partly on the grounds that it encourages the build up of debt.[12]

Advocates from an Austrian School or Libertarian
perspective often hold that money is equivalent to debt in our current
monetary system, but that it need not be in one where money has inherent
value, such as a gold standard.
They have frequently used this view point to support arguments that it
would be best to return to a gold standard, to other forms of commodity money, or at least to a monetary system where money has positive value. Similar views are also occasionally expressed by Conservatives. As an example of the latter, former British minister of state The Earl of Caithness made a 1997 speech in The House of Lords where he stated that since the 1971 Nixon Shock, the British money supply
had grown by 2145% and personal debt had risen by almost 3000%. He
argued that Britain ought to move from its current "debt based monetary
system" to one based on equity.[13]
In the early to mid 1970s, a return to a gold anchored system was
advocated by gold rich creditor countries including France and Germany.[14] A return has repeatedly been advocated by Libertarians, as they tend to see commodity money as far preferable to fiat money. Since the 2008 Crisis and the rapid rise in the price of gold that soon followed it, a return to a gold standard has frequently been advocated by goldbugs.[8][15]

Advocacy against the gold standard

From centrist [16] and left wing perspectives, credit theories of money
have been used to oppose the Gold Standard while it was still in
effect, and to reject arguments for its re-instatement. Innes's 1914
paper is an early example of this.[3][8][15]

Advocacy for expansionary monetary policy

From a moderate mainstream perspective, Martin Wolf
has argued that since most money in our contemporary system is already
being dual-created with debt by private banks, there is no reason to
oppose monetary creation by Central Banks in order to support monetary policy such as Quantative easing.
In Wolf's view, the argument against Q.E. on the grounds that it
creates debt is offset by potential benefits to economic growth and
employment, and because the increase in debt would be temporary and easy
to reverse.[17]

Advocacy for debt cancellation

Arguments for Debt forgiveness have long been made from people of all political orientations; as an example, in 2010 hedge fund manager Hugh Hendry, a strong believer in free markets, argued for a partial cancellation of Greece's debt as part of the solution to the Euro crisis.[18]
But generally advocates of debt forgiveness simply point out that debts
are too high in relation to the debtors ability to repay, they don't
make reference to a debt based theory of money. Exceptions include David
Graeber, who from a radical perspective, has used credit theories of
money to argue against recent trends to strengthen the enforcement of
debt collection, such as greater use of custodial sentences against
debtors in the US. He also argued against the over zealous application
of the view that paying ones debts is central to morality, and has
proposed the enactment of a biblical style Jubilee where debts will be cancelled for all.[6]

Relationship with other theories of money

Debt theories of money fall into a broader category of work which postulates that monetary creation is endogenous.[19]
In the forms commonly held by those to the left of the political spectrum, Debt theories have some overlap with Chartalism[20] and are opposed to Metallism and often to the Quantity theory of money.
Conversely, in the forms held by those with a Libertarian or
Conservative perspective, debt theories of money are often compatible
with the Quantity theory, and with Metalism at least when the latter is broadly understood.[3][6][8][21]

Notes and references

^Credit is understood as the mirror image of debt. As Innes mentions in What is money? (1913), whenever he uses the word credit or debt,
"the thing spoken of is precisely the same in both cases, the one or
the other word being used according as the situation is being looked at
from the point of view of the creditor or of the debtor."

^Originally published in The Banking Law Journal, since reprinted in books such as Wray (2004) and made available online by the CES

^Simply
put, this contrasts with exogenous creation where money is created by
events such as new finds of gold occurring outside of a narrowly
conceived economy.

^Chartalists
will sometimes say money derives it value by virtue of being the legal
way to pay ones debt to the State as taxes. Debt theories can be broader
in scope - Graeber, Innes and others have argued that organic debt
based monetary systems that did not involve the state continued to
operate well into the 19th century.

About Me

Robert Searle was educated in Windsor at the Royal Free, the Tutorials, and East Berkshire College. He is the originator of two major "work in progress" Paradigms known as Transfinancial Economics (TFE), and Multi-Dimensional Science (MDS).The former believes that new unearned money could be electronically created without serious inflation notably for key environmental, and
socially ethical projects. Multi-Dimensional Science though presents an unique "scientific" Methodology by which claimed psychic, and spiritual "phenomena"could possibly be "proved".
Apart from the above, Searle has proposed the development of the Universal Debating Project, an interactive "encyclopedia" of virtually "all" pro, and con arguments for practically any subject in the world.He is the creator too of a tribute blog on the musician, and broadcaster David Munrow (1942-1976), and a pioneering one on Contemporary Early Music.Furthermore, he has a very large audio-visual collection of Medieval, and Renaissance Music (manually created as Searle8), and has an "unusual" musical project involving improvisation which could also open up a "new" approach to music.